Random Walk Hypothesis and Foreign Exchange Market in Nigeria: An Empirical Evaluation of the Behaviour of Naira with Respect to Other Currencies

The Random Walk hypothesis of stock prices, is no doubt, one of the best-tested and best-verified financial econometric models. Regardless of its popularity and apparent validation by many statistical tests, however, the universal application of this financial theory remains a subject of debate. This debate becomes even more valid in the context of such unique and complex scenarios as the Nigerian foreign exchange market. characterized by the coexistence of official and parallel exchange rates, which complicates the management of the naira and the overall efficiency of the forex system. This study evaluates the relevance of the random walk theory within Nigeria’s foreign exchange environment by assessing whether the naira’s value against major foreign currencies - namely the US dollar, British pound, and Japanese yen - follows a random walk pattern or is influenced by current economic information. Monthly data spanning from 1986 to 2023, sourced from the Central Bank of Nigeria (CBN), the CBN Statistical Bulletin, the World Development Index, and Indexmundi were analyzed using the Augmented Dickey-Fuller Unit Root Test. Findings indicate that the exchange rate series for Exchange Rate to the Dollar (EXRD), Exchange Rate to the Pound (EXRP), and Exchange Rate to the Yen (EXRY) are stationary at level. Additionally, the ARCH test confirms the existence of ARCH effects across all models. Results from the ARCH model show that the exchange rate between the naira and the British pound exhibits a random walk, whereas the naira’s exchange rates to the US dollar and Japanese yen are influenced by past volatility. Consequently, the study recommends that the Nigerian government increase foreign reserves to support the naira and implement structural reforms alongside proactive forex market interventions to reduce the potential for market participants to earn abnormal risk-adjusted returns.